August 1, 2006

More reason to prefer the EITC to the minimum wage

While the Senate debates raising the unproven and logically flawed minimum wage, I found this paper, which credibly and formally collects the economic evidence of the Earned Income Tax Credit's effectiveness:

Twenty-two million families currently receive a total of $34 billion dollars in benefits from the Earned Income Tax Credit (EITC). In fact, the EITC is the largest cash transfer program for lower-income families at the federal level. An unusual feature of the credit is its explicit goal to use the tax system to encourage and support those who choose to work. A large body of work has evaluated the labor supply effects the EITC and has generated several important findings regarding the behavioral response to taxes. Perhaps the main lesson learned from the evidence is the confirmation that real responses to taxes are important; labor supply does respond to the EITC. The second major lesson is related to the nature of the labor supply response. A consistent finding is that labor supply responses are concentrated along the extensive (entry) margin, rather than the intensive (hours worked) margin. This distinction has important implications for the design of tax-transfer programs and for the welfare evaluation of tax reforms. [Emphasis added]
The debate on the minimum wage is whether it hurts employment or has no impact. The debate on the EITC is how effective it is and what small adjustments should be made to maximize its effect on welfare. What seems like the better option to you?